From M&G's Bond Vigilantes:
With Brexit in every headline, it’s hard not to form an opinion on
the possible outcome for the UK. Investors are getting increasingly edgy
about the impact on certain asset classes, and I have read many
articles predicting which sectors will do well in various exit
scenarios. Sterling credit has remained healthy since the referendum,
led by robust fundamentals and not by politics as the pound has been.
The sterling credit universe (as defined by the iBoxx £ Corporate
Bond Index) is largely an internationally influenced index, much more
correlated with what is going on in Europe and the US than in the UK
domestically. Of the top ten issuers, only two have their full working
operations within the UK (namely Heathrow Airport and Thames Water),
while the top issuer by index weight (3.3%) is French utility company,
EDF. Which just goes to show the international nature of the index – and
indeed perhaps some of the reason it has proven to be robust, with only
49.8% of the index British.
Since the beginning of the year the index has returned 3.3% (at 12 March 2019), while 2018 saw negative returns of –2.2%. By 6th
February, the sterling corporate index had regained all of its 2018
loss. The credit wobbles of Q4 18 offered good value and some better
entry points to investors, particularly in the financials sector. The
sterling financials index returned 3.3% year to date (12 March 2019) –
clearly the market has been somewhat assisted by recent headlines of
potentially softer Brexit scenarios. We have seen heavily oversubscribed
books for recent sterling deals, highlighting the difficulty in buying
inventory with dealer positions low.
Looking more closely at the companies which have performed best year
to date, we observe that it’s the challenger banks which have rallied
most. Challenger banks are smaller, recently created banks which
distinguish themselves from more established banks by modernising
technology which aims to avoid the cost and complexities of traditional
banking. Some such names are spins offs from larger institutions
following divestment or wind-downs of larger, mainstream banks.
In the current environment dealers are looking for higher beta
opportunities and, having underperformed in 2018, challenger banks
offered some attractive yields. Take TSB for example (a divestment of
Lloyds, sold to Spanish bank Banco Sabadell in July 2015). Year to
date, the spread compression is much more significant than in the case
of Lloyds, an established name in the UK banking sector. Does TSB pose
more risk? Yes, of course, but with its low credit risk business model
(they are mostly exposed to prime UK residential mortgage loans, which
historically have borne very low loss rates through the cycle), one
could make the case that investors are being well-compensated for this
in the spread....MORE
